A few years back, my husband and I were growing out of our two-bedroom, 850-square-foot rental in St. Petersburg, FL. We had one child, one cat, and lots of stuff. In short, it was time to move.
We didn’t think we were ready to buy, but a friend (it always starts with a friend, doesn’t it?) had recently bought using a Federal Housing Administration loan, and it was working out wonderfully.
My husband and I had decent credit scores and low debt, but we certainly didn’t have 20% to put down on a home. An FHA loan—which allows the buyer to put down as little as 3.5%—sounded like a dream come true. We found an FHA-approved lender, and in no time, we were on our way to buying our first home with a government-backed loan.
But in the middle of this process, someone asked us how much our mortgage insurance would be.
“Mortgage insurance?” I asked. “What’s that?”
Unfortunately, our lender hadn’t explained much about the rules and restrictions surrounding an FHA loan. We learned the hard way—after it was already a done deal. It didn’t stop us from landing our starter home. But here are four things I wish I’d known before I signed on the dotted line.
1. You’re on the hook for mortgage insurance for the life of the loan
Let’s get into the first thing you’ll have to factor in with an FHA loan: mortgage insurance.
This is a payment that’s usually required when the buyer isn’t putting 20% down. (You might know it as PMI, or private mortgage insurance; the FHA’s version is called MIP, or mortgage insurance premium.)
Now, the twist: It used to be that you had to pay this mortgage insurance on an FHA loan only until you gained 20% equity in your home. But under legislation passed in 2013, you can plan on paying that extra money for the life of the FHA loan. Yikes! (You can skirt this requirement if you put at least 10% down, but that kind of defeats the purpose of the sweet, low down payment option, right?)
All is not lost, though: Eventually, your monthly payments will go down as you whack away at your loan amount.
“But for the first few years, a buyer is paying mostly interest rather than principal, so the loan amount doesn’t go down for quite a while,” says Robert Harris, owner and mortgage consultant at All in One Lending.
2. You can’t buy just any house within your approved loan amount
As long as the bank thinks you’re good for the loan, why wouldn’t you be able to buy any house you want? Well, the FHA has a few more hoops to jump through than conventional loans.
To be approved for the loan, the house must pass an inspection conducted by the U.S. Department of Housing and Urban Development. A licensed, HUD-approved appraiser will determine the market value of the home and do a “health and safety” inspection to check for crucial problems such as a crumbling foundation or issues with the mechanical systems.
“Many people don’t know that the guidelines can be pretty strict for an FHA loan,” says Paolo Matita, a former real estate agent who says the inspection was an issue for his FHA loan–holding clients. “The roof, AC unit, plumbing, and electrical all need to be fully functional and be able to last for several years if they’re going to pass inspection.”
(Note: This inspection is not a substitute for a regular home inspection, which you should absolutely get, too.)
What’s more, if the house requires certain repairs in order to pass inspection, they must be completed before the sale can go through. This can create another hurdle for FHA buyers: You either fork over the money to make the repairs, or ask the seller to take on the cost—a pretty big risk, especially in today’s seller’s market.
In the end, you might end up having to walk away from the deal.
3. You might not be able to use your loan for renovations
My husband and I found a house that had potential but needed serious TLC. The home was under budget, so we thought we’d just tap the unused portion of the loan to make repairs. No biggie, right?
It turns out, the type of FHA loan we’d signed onto didn’t allow renovations. Had we done more research upfront, we would have discovered that there is a loan out there that would have allowed us to buy and repair that fixer-upper: an FHA 203(k) loan.
With a 203(k) loan, you can dedicate up to $35,000 for home improvements. The lender will have a say in what kinds of repairs you can make, but the 203(k) loan can be a great solution for first-time home buyers who don’t mind doing a little work.
4. You still need decent credit for an FHA loan
While we didn’t have ultrahigh credit scores, getting an FHA loan wasn’t a free-for-all: Buyers must have a 580 credit score to take advantage of the 3.5% down payment option. Lenders also have a stake, and will often demand a credit score of 600 or higher to qualify. (Our lender required a credit score of 665 or better.)
An FHA loan afforded us a rock-bottom interest rate with a low down payment. But don’t assume an FHA loan will be a slam dunk into homeownership—do your homework and weigh the pros and cons to determine whether an FHA loan is truly right for you.
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